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Stock Market Reports
Toyo Securities
Translation of Japanese market strategy
When I came to Japan in 1985 to work I knew no Japanese whatsoever. I wanted to be fluent within a couple of years; some 18 years later, I'm still struggling toward that goal. I've made good progress in one area: translating business and financial documents into English. Stock market strategy reports can be particularly challenging, since they require a knowledge of technical analysis peculiar to Japan.
To view a sample of the original Japanese text, please open ToyoSecJap.gif
Market Report for October 2, 1998
For the second straight week the Nikkei reached a new post-Bubble low, owing to downward revisions of company results and some disappointing fiscal first-half reports. The BOJ's Tankan survey, announced on October 1st, showed declines in all sectors, and the results were once again worse than expectations. The poor numbers reinforced the sense of the seriousness of Japan's economic decline, and on October 2nd the Nikkei momentarily went below the Y13,000 range. Even though the agreement between the ruling and opposition parties eliminated some of the political instability that had been hurting the market, many observers also felt that the agreement would accelerate credit contraction and force banks to further limit their lending. On the over-the-counter market, Tescon Ltd. (6865), which had been expected to report record-high earnings for the period, for the first time dishonored bills. That prompted investors to ask whether we would be seeing a trend of credit contraction bankrupting viable companies, and consequently the Nikkei over-the-counter index fell to a record low.
This week as well the TSE is expected to grope with lower prices. The reasons are, first, as noted above, the Tankan numbers reinforced the sense of a worsening economy and poorer company results. For this period, it is possible that ordinary income of the TSE's first section companies will be down 30% to 40% year over year. The second reason is the government's lack of leadership on financial issues. A policy for public investment in faltering financial institutions and the curtailing of lending by banks has not been settled on. Thus, we will probably see further unwillingness by banks to lend. The future of bills to restore quickly the health of financial institutions, which are to be debated in the Diet this week, also add to the overall uncertainty. The third reason is overseas trends and the G7. There is concern that the problems of hedge funds will expand. The final reason is that Japanese companies are selling out positions in their effort to reduce stock valuation losses for the September midyear period.
The September Tankan was the first since November 1989 that showed a decline in all sectors. Especially notable were the decline of 37 points in general machinery (from -12 in June to -49 in September) and a drop of 24 points in nonferrous metals (from -33 in June to -57 in September). The BOJ is cautiously estimating that the survey in December will show only a five-point improvement for all sectors, gaining to
-46 from -51 in September. With the exception of precision machinery, which should be worse in September than in December, there should be a general improvement in other sectors - especially in autos, where a 22-point improvement is expected.
Also, the IMF estimated that Japan's GDP would decline 2.5 percent in 1998. Following the IMF's forecast, the Economic Planning Agency (EPA) estimates a 1.8 percent drop, the biggest downward revision since the end of World War II. It is thought that overall the market is already discounting these numbers, but as we move into October we'll see the peak period of companies following one another in making downward earnings revisions. That is the biggest negative the market is currently facing. Another negative factor for the market is that the Y16 trillion in public investment initiated earlier by the Japanese government is not making itself felt as fast as expected.
Concerning political issues, on October 2nd the LDP presented to the opposition its plans for protecting Japanese financial institutions before they become insolvent. Public funds will be injected into financial institutions in distress -- depending on their net worth ratio -- from a financial resuscitation account which is to be established within a framework of a deposit insurance system. The scheme includes the following formulas:
- When the net worth ratio is below 4%, premised on ensuring that shareholders assume the burden of their losses through capital reduction, the government entity could provide capital by acquiring in excess of 50% of the institution's common stock, with additional injections of capital through government purchases of preferred shares.
- In the case of healthier financial institutions having a net worth ratio of 8% or above, the government entity could purchase their preferred shares if they were to request help.
Concerning how to calculate the net worth ratio, under the LDP proposal the present system of electing either (1) cost or market, whichever is lower, or (2) the cost method, is maintained. The opposition, however, strongly insists on the use of only the cost-or-market method, and a battle over this issue can be expected.
Also, attention will be focused on the contents of a competing plan to be proposed by the Democratic Party of Japan. Since the government eventually accepted all of the opposition's plan for the Long-Term Credit Bank of Japan (LTCB), this time too we can expect a similar conflict between the ruling and opposition parties.
However, many observers believe that, even if a new scheme is established, it will not make banks more willing to lend. Indeed, depending on conditions, banks may become less eager to lend. The politicians are just concentrating on getting bills passed, without taking sufficient care about their contents. They are getting away from the real goal of reforming the financial system and escaping the financial crisis. Instead, they are using the various plans as a way of trying to gain political power. As long as these kind of actions continue, credit contraction will become more severe and stock prices will continue lower.
If we take a look at what is going on internationally, over the past several days there have been continued rumors about the bankruptcy and liquidation of hedge funds. The declines in New York and European stock markets are having the effect of lowering the Nikkei because of profit-taking. The key will be whether we will see global cooperation, through the G7 or otherwise, on setting up a scheme for the hedge fund problem.
At the end of September, the Nikkei was Y13,406.39, well below the Y16,527.17 at the end of March. There is concern that there will be a significant worsening in company results because of valuation losses. At the end of September, market capitalization was down Y391 trillion yen from its peak at the end of December 1989. That figure is about five times the government's budget for fiscal 1998. Most of the loss in market value has been in bank shares, which represented 11.5% of market capitalization at the end of September versus 23.2% at the end of 1993. It is easy to understand that even mutual funds that are passively managed may reduce their purchases of Japanese bank shares.
The fall in bank stocks has worsened the tone of the overall market. Because bank profits are declining owing to bad debt write-offs, there is increased pressure on banks' capital, and they are more unwilling to make loans. Since companies need cash, they are selling bank stocks. That results in lower bank stock prices and a lower overall market. This chain reaction has become a vicious circle. We need to focus on whether the Diet will look at ways at stopping this vicious circle.
The market remains depressed, but some observers, based on the "rule of the 8-year cycle," think we're near a bottom. In 1974, 1982, and 1990, a bottom was recorded, and each time it came in October. Coincidentally, the economic environment has also changed every eight years. In 1974, with the German bank Bankhaus ID Herstatt KgaA ceasing operations and America's Franklin National going bankrupt, the developed nations changed their economic policies toward stimulation. In 1982, as concerns grew over global recession, the US made successive cuts in the discount rate. In 1990, with a depression in stock trading and a big drop in land prices, the Japanese Finance Ministry initiated policies to boost stock prices. The next day the Nikkei climbed Y2,676. This time, if we see within two weeks a dramatic change in Japan's political situation, as some observers believe, there is the possibility that we'll see a bottom in the market during the first three weeks of October.
Foreign investors are becoming still more eager sellers of Japanese stocks. From the first to fourth week of September, their sales exceeded purchases by a substantial Y609 billion. Two weeks ago, attention focused on the large sales of blue-chips, bank stocks, etc. by large American mutual funds like Putnam and big US pension funds like Calpers. Last week, in addition to US investors, European and Middle East investors sold blue chips as well as small, well-regarded stocks. On Friday the 2nd, it was rumored that the sharp declines in Sony, TDK, Canon, etc. and smaller stocks like Ryohin Keikaku and Yamada Electric Manufacturing reflected sales by a major Middle East institution. With the big correction in US stocks, the stock portfolios of American mutual funds decreased in August by $11.2 billion, the biggest monthly decline ever. With economic chaos in Russia and a major hedge fund bankruptcy, this trend seemed to accelerate in September. The supply/demand situation in the top Japanese blue chips should continue.
Another major investment force, large Japanese companies, were making the supply/demand situation worse. By the 4th week of September, they had sold Y115 billion more than they had bought. Contrary to the expectations that their sales would moderate after September 25 (for settlement in October), they are in fact on the increase, as liquidation of cross-shareholdings accelerate. Until September 30, we saw companies using same-day settlement, and once into October they are being forced to continue their selling in order to acquire funds because of banks' unwillingness to lend. This trend by companies should continue for a while, and even if the market improves, they are not expected to slow their selling activities.
In the last two months, individual investors have continued to buy more than they sold. But in the last week of September, buys in excess of sales fell to Y11.9 billion, compared with Y34.3 billion in the previous week. For this week, the trend points to more sales than purchases.
The current market is in the process of reflecting the credit contraction and credit risk that has appeared. It seems that these factors won't disappear easily, and the stock market will remain depressed. In order for the economy to bounce back, it will be necessary to have a radical economic policy, on a scale large enough to lead to an improvement in consumer sentiment, which accounts for changes in the largest demand-sector in the economy. So far as stock selection, for lack of anything better, defensive stocks can be bought. World stock markets are taking on a different tone, with operating funds going into commodities, and thus gold and oil prices are trending higher. We would pay attention to companies that will derive advantages from this situation.
Also, among major stocks, there are those reporting bad results that are selling at prices below pre-bubble levels. Based on the standards of price-to-book value and credit rating, investors need to prepare for taking action in a change of market direction.
To view a sample of the original Japanese text, please open ToyoSecJap.gif
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